I recently caught up with my Uncle David at a family wedding. While shooting the breeze, he told me that he had just retired. He reminded me, after all, that he had just turned 65. However, he was concerned about outliving his retirement income — a common concern amongst most retirees.
As far as my uncle goes, I get his concern. He’s in great health and our family has excellent genes. So, I recommended that he purchase an annuity. Before I could go any further, he told me that he had already done his research and annuities are appealing. But, he’s not exactly sold on them just yet.
If my uncle bought an annuity with a $100,000 deposit he could receive away $500 per month. That’s not too bad as a supplemental retirement that’s guaranteed for the rest of his life. So, what was holding him back?
My uncle never married and doesn’t have kids. That means he’s not worried about further beneficiary payments or death benefits. But, what if there’s money left over when he passes away? The insurer will keep the remaining amount of the annuity. And, he’s not too keen on that.
After explaining his concern, I suggested that he explore a straight life annuity.
What is a Straight Life Annuity?
Just will all other types of annuities, a straight life annuity is a contract between you (the annuitant) and an insurance company. With an annuity, a lump sum is usually paid up front, and the insurer assures the annuitant that they will receive fixed regular payments for the rest of their lives. Typically, an annuitant purchases a straight life annuity a few months before he or she wants regular payments to begin, and they start receiving payments shortly thereafter.
In most cases, the annuitant will receive payments for the rest of their lives. As a result, the annuitant will never face a financial crisis since they will never outlive their income. The annuitant is also able to select alternative payment frequencies, such as quarterly or annually, though payments are often made monthly.
A key benefit of the straight life annuity is that annuitants will receive the highest regular payment for the amount of the lump sum they deposited. It’s possible to purchase an annuity with a range of payment terms, such as one that provides a death benefit to a beneficiary or one that continues payments to a beneficiary if the annuitant dies early. The annuitant will, however, be paid less money while they are alive than they would on a straight life annuity.
In the case of straight life annuities, the regular payments increase with inflation or other factors rather than remaining constant throughout the individual’s lifetime. However, inflation-indexed annuities will have lower initial payments than fixed annuities.
The unique aspect of a straight life annuity is that after the annuitant dies, the payments stop and he or she, their spouse, or heirs receive no money or death benefits. This makes straight life annuities less expensive than many other types of retirement income and annuities.
How a Straight Life Annuity Works
Depending on how you decide to pay for the straight life annuity, you can either make a series of payments or purchase it all at once. In most cases, if you are close to or already retired, you should purchase your annuity upfront so you can begin receiving payments immediately. Alternatively, it may be more manageable to pay for your annuity in installments if you are several years away from retirement.
Straight life annuities are most commonly purchased between the ages of 45 and 55 by individuals who are not yet retired.
In spite of the payment option you select, the benefits are the same for you. When you purchase your straight life annuity, you have the option to include a Cost of Living Adjustment (COLA) if inflation is a concern. Essentially, 3% is added to your benefit each year and it’s compounded annually.
A straight life annuity can be funded in several ways, such as;
- Cash or savings
- Fund transfers from qualified retirement plans, like a (401(k) or IRA
- Transfer permanent life insurance cash values through a 1035 exchange
- The sale of stocks, mutual funds, or other publicly traded securities
If you fund your annuity with pre-tax dollars, such as from a qualified retirement plan, you’ll pay taxes on your annuity payments. Unless you live beyond your life expectancy, however, and your annuity was funded with after-tax dollars like from your personal savings, you will not owe taxes on annuity payments. As an example, the payouts from an annuity purchased at 65 that cover payouts for 20 years will be taxed at age 85 if the payouts are spread out over those years.
Pros and Cons of Straight Life Annuities
Does a straight life annuity policy make sense? The answer depends on your individual situation. But, to help you make this decision, here are the pros and cons of straight life annuities.
- Guaranteed retirement income. During retirement, annuitants receive an income that is guaranteed to last throughout their lives.
- Higher payouts. There is no beneficiary component to straight life annuities. When the annuitant dies, payments cease. As a result, the annuity company can offer higher payouts. Overall, straight life annuities usually have the highest payouts out of all annuity types.
- No death benefits. Upon your death, the insurance company does not make any remaining payments from your annuity. As a result, your beneficiaries are ineligible and your survivors will not receive anything. In short, those who need a legacy planning tool should not opt for this type of annuity.
- You could lose money. When you die, your beneficiaries are not entitled to anything if the annuity payments you have received are less than the account value. Therefore, if you die before breaking even, you are likely to lose money.
Straight Life Annuity Payout Options
Straight life payout options can be combined with most other annuity types. These annuities offer a life payout option, for instance.
It is usually not until you elect to annuitize that you pick your annuitization option. Due to this, you can choose the payout option that works best for you when it’s time to receive the income from an annuity.
- Straight Life Immediate Annuity. You begin receiving payments very soon after purchasing this type of annuity due to the large investment that you made.
- Straight Life Deferred Annuity. An annuity with time to grow and accrue interest is a straight-life annuity.
- Straight Life Variable Annuity. With this annuity, the investment portfolio controls the payment amount.
- Straight Life Fixed Indexed Annuity. You can consider this a hybrid annuity that provides principal protection but is also linked to an index, such as Nasdaq.
- Straight Life Fixed Annuity. The interest rate on your annuity will be fixed, making this a more predictable and safer investment option.
- Single-Premium Straight Life Annuity. A one-time lump-sum payment funds this straight life annuity.
- Flexible-Premium Straight Life Annuity. You can fund a straight life annuity by making several premium payments over time through a series of payments.
There are different types of straight-life annuities with varying levels of risk and payoff potential. Which one is right for you will depend on your financial situation and retirement goals. Here are some retirement savings by age recommendations.
Best Candidates for Straight Life Annuities
Single adults who do not have a spouse or other dependents can benefit the most from straight life annuities. In other words, you’re not looking to pass down generational wealth.
Those who have other income and assets, married or single, and plan to put only a portion of their retirement nest egg into the annuity, may also find the single-life annuity appropriate. The guaranteed income from the annuity formula allows an individual to invest more proactively with the remainder of his or her portfolio to pursue a potential higher return. The annuity also assures a minimum level of income regardless of how the market behaves.
If you have children but have already set aside other assets for them, a straight life annuity is an option to consider.
There are studies that indicate that when a retirement nest egg is part of an annuity that pays income for life, the nest egg lasts longer than when it isn’t part of an annuity. Many financial advisors recommend that retirees have guaranteed income, from Social Security and annuities, that at least equals their fixed, required expenses during retirement.
Straight Life Annuity Alternatives
If you aren’t an ideal candidate, there are other options for guaranteed retirement income that your family can choose from besides a straight life annuity.
Cash refund rider.
Although technically not an alternative to a straight life annuity, a cash refund rider lets you to personalize your annuity in order to leave a benefit to a loved one if you die. Any remaining balance is given to your beneficiary after payouts are deducted from the premiums paid.
While it shields your beneficiary from longevity risks by making sure no premium is wasted, it may be subject to tax when the payout is made.
Period Certain Annuity
As with a cash refund rider, a period-specific annuity may provide your beneficiaries with funds in the event that you die suddenly. Your beneficiaries will be eligible for annuity benefits for a predetermined period (typically 10 to 20 years).
However, if you outlive the period, no benefits will be paid. Those who are well into retirement or have health conditions that limit their longevity may benefit from this, as their life expectancy may be significantly lower. Be aware that benefit recipients may need to pay taxes on their inheritances.
Life Plus Period Certain Annuity
With this option, you can enjoy the benefit of receiving a lifetime payout from a straight life annuity, while also having the option to leave unused premium payments to a beneficiary. Basically, it’s a hybrid product with a specific payout period (usually 10-20 years) or for the life of the customer, whichever comes first. There may be tax implications.
Joint-to-survivor annuities payout regardless of who dies first if your spouse does not have an additional income stream. By doing this, a spouse will no longer be left without retirement income or financial support after one of you has died. Those without dependent children, who aren’t concerned with passing down their wealth, or whose beneficiaries own other assets can benefit from this option.
With joint-to-survivor annuities, you may arrange payouts to be at least 25-50% greater while both you and your spouse are still alive and to be reduced after one of you has passed away. This can help maximize your annuity payouts. Furthermore, some insurance companies provide more benefits if the survivor is a spouse, compared to other beneficiaries.
Whole Life Insurance
Do you want to pass down generational wealth? Or, do you want to provide financial assistance for your dependent? If yes to either, you may want to look into a whole life insurance policy. The plan not only provides a guaranteed death benefit but also a guaranteed rate of return and dividend potential. You can use these earnings for tax-free retirement income or for other purposes. It offers the most guarantees and is the least volatile of the different types of permanent life insurance.
Frequently Asked Questions About Straight Life Annuities
1. What is a straight life annuity?
A straight life annuity ensures that the annuitant, who is the person entitled to the income benefits of an annuity, will continue to receive payments for life. In other words, straight life annuities do not have an expiration date or time limit. The annuitant can decide to receive payments monthly, quarterly, semiannually, or annually.
Typically, when you purchase an annuity you can select a beneficiary to receive money from your payments after you die. If you buy a straight life payout annuity, however, this benefit is not available. As such, the annuitant will receive higher guaranteed payments while they are still alive instead of a death benefit.
2. How much does a straight life annuity cost?
Straight life annuities can be funded to any level you choose, as with other annuities.
You will receive more income in your payouts if you contribute more money through your premium payments. In general, annuities are funded by your savings or your IRA. Other options are by selling stocks, mutual funds, or even the surrender value of a life insurance policy.
3. How much does a straight life annuity payout?
In addition to your life expectancy, your payout amounts vary based on several factors. In most cost cases, though, straight life annuities offer the highest payouts out of all payout options.
4. Is a straight life annuity taxable?
In short, yes.
A straight life annuity is tax-advantaged, just as other annuities. A straight life annuity grows tax-deferred, meaning you don’t pay tax until you receive the income. The result is a faster growth of your account value. However, most people pay taxes in retirement because of this.
Due to their lower incomes in retirement, though, most people fall into a lower tax bracket. That means paying your annuity taxes at a lower tax bracket will result in lower overall taxes.
5. When does a straight life annuity benefit married couples?
Annuities are typically structured in such a way that the surviving spouse can continue receiving income after the annuitant passes away.
If a married couple has another source of income, a straight life annuity may make sense. A holder of an annuity can maximize retirement income without worrying that his or her surviving spouse will be left with nothing.